Palo Alto Piles On the Free Cash Flow

We are raising our price target for Outperform-rated Palo Alto Networks to $105 from $90.

Palo Alto (ticker:
PANW
) is quickly becoming the platform play in security. With strong fundamentals, the fastest ramping profitability in enterprise IT and launches into emerging opportunities, we believe shares deserve a premium valuation.

Our calendar second-quarter network security checks point to continued significant share-gain shifts to Palo Alto and rising traction as a security platform play. We believe the company continues to differentiate itself from the competition with a focus on applications enablement and the expansion into advanced persistent threat protection (APT) and endpoint. In addition, all signs point to subscription revenue remaining north of 60% growth.

We believe the free-cash-flow story is still underappreciated by Wall Street as the company is expected to ramp operating margins from approximately 9% today to over 22% as the company exits the quarter ending July 2016. Despite the company ramping up investments in new opportunities, it should be able to leverage a maturing sales force, as well as a channel presence that continues to crescendo.

Recent security breaches have served to highlight the increasingly strategic importance of security to the health of an enterprise, creating incremental opportunity for the entire industry. In our view, Palo Alto is outmaneuvering its competition and is capturing a material amount of share. In addition, as the premium name in the space, we believe new forays into the data center and endpoint are likely to be well-received by the marketplace.

Our new price target is based on roughly 9.0 times enterprise value-to-estimated 2015 revenue, or 35 times estimated free cash flow.

— Rob Owens — Ben McFadden

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